Deals Fade, and Airlines Look to Cut

Thursday

May 29, 2008 at 4:51 AM

As additional mergers in the airline industry look less likely, American carriers face a future of making further cuts to survive in an era of soaring jet-fuel prices.

As the likelihood of additional mergers in the airline industry dims, big United States carriers face a bleak future of making further cuts on their own to survive in an era of soaring jet fuel prices.

Consolidation had been seen as the most palatable way to shrink the industry — by grounding planes, eliminating routes and cutting staffs — to ensure profitability.

The prospect of further mergers, beyond the already-announced Delta Air Lines deal with Northwest Airlines, would have also offered airline executives a ready explanation of why cutbacks in service and staff were needed.

United Airlines and US Airways have long been considered merger candidates. The chief executives of each airline are scheduled to meet Thursday, but there has been little to no recent contact between teams of executives at both companies in talks that began weeks ago.

Outside bankers and lawyers assigned to the project have put it on “permanent hold,” waiting for instructions, one person involved in the talks said. Officials at United and US Airways declined to comment.

The talks could be revived. But in addition to the usual obstacles to an airline deal — like winning the support of labor unions — there is growing time pressure. The Delta-Northwest merger could be the only one that will take place in time for Bush administration scrutiny. Any other combinations would most likely face the uncertainty of a new administration.

If United, US Airways and other airlines are forced to cut costs on their own, the pain could be magnified since it will be their own doing, not the result of a strategic step accompanied by pronouncements of a stronger future.

“Nothing is equivalent to the lightning strike that comes with a merger,” said Michael Useem, professor of management at the Wharton School at the University of Pennsylvania.

High fuel prices, the force driving the airlines’ difficult actions, provide less drama, of course. And the rise in jet fuel costs, up 82.5 percent over last year, has come incrementally.

Airline industry losses could top $7.2 billion this year, Jamie Baker, an analyst with JPMorgan Chase, estimated recently. Some analysts estimate that airlines will have to raise fares on all routes by about $60 to offset the impact of rising fuel prices.

But they have already pushed through many fare increases, and have resorted to a number of fees and surcharges to bring in more revenue.

The current situation is not what analysts expected when Delta and Northwest announced their deal on April 14. The agreement jump-started United’s efforts to seek its own deal, and fed predictions that other airlines might combine.

But United failed to reach an agreement with Continental Airlines. And its discussions with US Airways have bogged down. United’s chief executive, Glenn F. Tilton, and his counterpart at US Airways, W. Douglas Parker, were scheduled to meet Thursday to review whether to continue exploring an arrangement, people with direct knowledge of the meeting said.

Mr. Tilton and members of the United board recently raised concerns about the risks involved in the transaction, although both sides had agreed the deal could provide value to each airline, these people said.

Delta and Northwest could benefit from their merger’s status as the lone deal, if no others occur. The chief executives of those airlines have been grilled by members of Congress about the arrangement. Both companies have pledged not to make deep cuts, a concern for lawmakers who fear mergers might hurt airports and customers in their districts.

Yet, the cuts might happen any way, said Philip A. Baggaley, a senior credit analyst with Standard & Poor’s Ratings Services. “The near-term task for all the airlines is the same, whether they’re planning to merge or not. That is to cut nonfuel costs where possible, trim flying in the domestic market and try to raise fares even more,” he said. “It’s really back to basics.”

The airlines’ dilemma is in contrast to early 2007, when US Airways made an unsuccessful bid to acquire Delta. Carriers were generally profitable back then because of extensive cost-cutting under bankruptcy protection or through reorganization efforts.

Fuel prices were modest compared with today, and airlines were able to push through modest fare increases. But this year, the industry expects a decline in summer travel, accompanied by layoffs and rising airfares.

“It’s the speed of the increase in fuel prices and the fact that it’s occurring in a weak economy which have created such problems for the airlines,” Mr. Baggaley said. Last week, S.& P. placed nine more airlines on credit watch with negative implications, meaning it was likely to cut their debt ratings.

They include the biggest carrier, American Airlines, which has begun announcing details of how it will cut 11 to 12 percent of its flights this year.

On Wednesday, it said it would eliminate its daily flight between Kennedy Airport in New York and London Stansted Airport, effective July 2. On Tuesday, American said it would discontinue flights between Chicago and Buenos Aires as well as Boston and San Diego. Both are halting on Sept. 3.

Even the steps American has announced will not make things much easier. “It looks like American will be flying into a headwind, no matter what it does for the rest of the year,” Vicki Bryan, an analyst with Gimme Credit, wrote in a research report on Wednesday.

Such prospects are why airlines may still view mergers as the ultimate solution to their problems, Professor Useem said. “Consolidation has such a well-worn proven history” in other industries, he said. “I can’t imagine the discussion will end.”

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